Roth IRA Distribution Tax Puzzle

It is February 1st, 2000, and your 30th birthday.

You begin a lifelong annual process to partially convert $1000 from a fully deductible traditional IRA to a conversion Roth IRA. There will always be sufficient funds in the traditional IRA to continue and the Roth IRA always will have a positive investment return every year.

What is the earliest year, if any, that you can take a complete distribution of the Roth IRA without incurring any tax or penalties?

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I believe that once your

I believe that once your turn 59 1/2 (i.e. August 1, 2029), you can take it all out tax free, because 5-year rules on conversions would no longer apply.

Doug, From Publication 590

Doug,

From Publication 590 -

Distributions of conversion contributions within 5-year period. If, within the 5-year period starting with the first day of your tax year in which you convert an amount from a traditional IRA to a Roth IRA, you take a distribution from a Roth IRA, you may have to pay the 10% additional tax on early distributions. You generally must pay the 10% additional tax on any amount attributable to the part of the amount converted (the conversion contribution) that you had to include in income. A separate 5-year period applies to each conversion. See Ordering Rules for Distributions, later, to determine the amount, if any, of the distribution that is attributable to the part of the conversion contribution that you had to include in income.

The point of confusion for me is the definition of "early distributions."

Is it only a distribution taken before age 59 1/2 or is it also a violation of the 5 year rule as above?

Thanks, Don

This chart:

This chart: http://www.irs.gov/publications/p590/15160x04.html seems to conflict with the paragraph you quoted. The first question is "Has it been at least five years from the beginning of the year in which you first set up and contributed to a Roth IRA?" In your example, that year is 2000, so the answer would be "Yes". The next question "Were you at least 59 1/2 years old?" would be answered "Yes" in my original answer, which means, according to the chart, you absolutely do not owe taxes or penalties.

Your quote, from the same publication, states "A separate 5-year period applies to each conversion." In which case, the answer to your question is that you can *never* take a complete distribution so long as you are making a yearly conversion.

Since I wouldn't want to pick a fight with the IRS, I would interpret the apparent conflict in favor of the IRS, and would stop making conversions five years before I turned 59 1/2 (or whenever I expect to take a complete distribution) to avoid any potential for dispute.

BTW, Roth IRAs seem to be a good way to pass wealth on to your descendants. Since there are no minimum distributions, and distributions are always tax free (as long as you wait long enough, that is), you could set up an annuity that never runs out, and is never taxed. It is only limited in value by how much wealth you can create in it.

Doug, I think that the chart

Doug,

I think that the chart only applied to contributions, but I didn't go back to double check.

Your quote, from the same publication, states “A separate 5-year period applies to each conversion.” In which case, the answer to your question is that you can never take a complete distribution so long as you are making a yearly conversion.

Yes, but also, because of the ordering rules, you would never be able to access a penny of earnings until you had exhausted the conversions, including the ones still within the 5 year period.

The 5 year periods for each conversion were added to prevent a two step penalty avoidance. If you took money out of a traditional IRA before 59 1/2 you would owe both tax and a 10% penalty. If you first converted to the Roth and paid the tax, you could then distribute the conversion without the penalty if the special 5 year rule for conversions did not exist.

This is clearly useless if the conversion occurs after 59 1/2, but the question is whether the rule accomplishes anything if the 5 year period has the 59 1/2 year age in the middle. Is there any reason that it doesn't make sense to terminate all 5 year periods at age 59 1/2 ?

Not that sense has anything to do with it, but I can't think of any undue advantage that would be gained if the 5 year periods were not terminated at 59 1/2.

Regards, Don